As news that talks had concluded with a potential deal to end the sanctions on Iran rippled throughout the world on Tuesday, a variety of people were immediately dissatisfied. Benjamin Netanyahu offered a fiery rejection of the deal which, you know, just shocked the heck out of me. It was also panned by Congressional Republicans. Again, news that is just coming completely out of left field.
However, one group that might not be thrilled about this deal is the oil companies. The supply glut that has caused crude prices to plummet to under $60 a barrel from over $100 is likely not going to improve when Iran throws its hat back in the ring.
So, now would not be the time to be perusing small-cap oil stocks, right? Low oil prices will affect the entire industry uniformly, so why bother even digging around? In a word: hedging. For those oil companies that are already hedged against low oil prices, an Iran deal is really just expanding an existing competitive advantage they’ve gained by protecting themselves when oil prices were high.
And, of course, for a shrewd investor, that could mean that an end to sanctions for Iran could make for an intriguing buying opportunity if pursued carefully and with the appropriate research.
How to Make Money When Your Industry is Tanking
Any company that is spending large sums of money and years of work acquiring a certain type of commodity is likely to at least consider a hedging strategy. Typically, this would involve buying some combination of futures, options, and swaps to secure the right to sell at a certain price in the future.
This can be risky, though. You might secure the right to sell your oil at $90 a barrel for the next year when prices are at $100 a barrel, but if the Saudi oil minister announces the next day that his country “really isn’t feeling oil anymore” and prices shoot up to $250 a barrel, you’re going to be kicking yourself. Depending on the structure of your hedge, you’ll either be forced to sell at $160 under market prices or you’ve spent a substantial sum of money on hedging contracts that are now worthless.
Heck, even if the price holds steady, the cost of the contracts will eat into the company’s profits without providing any value. This usually results in complex, interlocking options and swap strategies like three-way collars or butterfly spreads that can make for wildly different outcomes depending on market conditions.
However, as we all now know, prices did not rise or hold steady. They fell…a lot. And once they hit a low, they stayed there. Meaning that, at this point, those companies that were the most aggressive in their hedging strategies in mid-2014, securing contracts during the market’s peak that extended into 2016 or even 2017, are currently sitting in the catbird seat relative to their competitors. They took a big risk back then, and it has paid off in a big way.
Finding the (Relative) Best Bets for Playing Oil
So, which companies are prepared for this? Which were the most aggressive in protecting their bottom line, buying up futures contracts or options that extended well into 2015 or even to 2016?
That is, unfortunately, not an easy question to answer. Anyone seeking a really comprehensive look at a company’s hedging portfolio will need to spend some real time digging into its SEC filings. All the same, here’s a look at some small-cap oil companies that appear to be well hedged, potentially providing them with a short-term advantage that an end to sanctions in Iran will only improve.
Gastar Exploration (GST)
Market Cap: $199.62 million
Gastar is an independent oil and gas company with assets functioning in the Marcellus Shale and the Hunton Limestone formation. The company’s Q1 earnings report showed production reaching 4.1 million barrels a day, a nearly 80% bump over the year prior, in addition to 36.6 million cubic feet per day in natural gas.
That sort of bump in production for crude oil in the first quarter following the dramatic decline in prices would seem pretty odd. However, as of December of last year, the company had a pretty healthy hedge in place. Some 95% of its oil production was hedged at $91.77 a barrel for 2014 and 86% is hedged at $86.91 for 2015.
Bill Barret Corp. (BBG)
Market Cap: $357.85 million
Bill Barret Corp. is a Denver-based independent oil and gas company with assets located primarily in Colorado and Utah. The company isn’t without its own issues, including a relatively troubling debt-to-equity ratio that might raise a few eyebrows, and a Q1 earnings miss that contributed to a more-than 35% decline year-to-date.
That said, Bill Barret can boast one of the better hedge portfolios out there. The company confirmed in its Q1 earnings report that it had used commodity derivative swaps to hedge 90% of its 2015 oil production at an average of $92.33 a barrel. Add to this hedges for about half its 2016 production at an average of $87.50 a barrel and Bill Barret might be a company that’s prepared to try and wait out the current power play by Saudi Arabia.
The hedging portfolio may have played some role in the recent decision by analysts at Deutsche Bank to upgrade their rating from “hold” to “buy” and increasing their price target to $14.
Pengrowth Energy Corp (PGH)
Market Cap: $1.19 billion
Pengrowth certainly didn’t manage to avoid all of the risks of crashing oil prices. The company posted a net loss in Q4 of 2014 of $506 million and a net loss in Q1 2015 of $160.5 million, largely due to collapsing oil prices, and it had to take action to protect itself in cutting its capital program and dividend. This likely contributed to the more-than 30% decline the company has experienced in 2015 thus far.
But, no matter how ugly things are for now, Pengrowth can be pretty thankful that they prepared for lower oil prices in one key way: hedges. The company has hedged about ¾ of its FY 2015 production at a price of $93.96.
Pengrowth currently has the look of a former mid-cap living life as a small-cap due to crashing oil prices. It’s down almost 70% over the last year. However, that dramatically lower price could just as easily be seen as creating a real value buy. Any time you can buy a piece of a company for about a third of its price a year ago, it’s at least worth a second look.
BreitBurn Energy Partners (BBEP)
Market Cap: $881.78 million
Los Angeles-based BreitBurn Energy has a lot of fingers in a lot of pies, operating oil and gas wells in some seven different regions across the United States. Like pretty much every other company in the industry, its share price is way down over the last year, crashing almost 85% over that period.
BreitBurn, however, can boast a pretty solid hedge portfolio. And yes, boast is the right word, as the company conveniently posts some of the details on its hedge portfolio right on the company website.
BreitBurn has hedged about 75% of its FY 2015 productions hedged at $93.51 a barrel, 64% of its FY 2016 production at $89.01 a barrel, and almost 40% of FY 2017 production at $85.32 a barrel. All told, the length of those hedges could mean BreitBurn is ready to hold out on the current market conditions for some time.
Memorial Production Partners (MEMP)
Market Cap: $1.26 billion
Memorial Production Partners has had a better 2015 in terms of its share price than many of the other companies listed here, declining less than 10% over that period. It’s down over 40% over the last full year, but that’s still relatively strong when compared to a lot of the rest of the industry.
The company also has a pretty solid hedge portfolio that has its current and future oil production well protected. According to a presentation from March of this year, the company has 85-95% of its 2015 production levels hedged through 2018 and almost half that hedged for 2019. And, in each case, it’s hedged at more than $80 a barrel. This includes 89% of 2015 production hedged at $91.08 a barrel.
Memorial Production Partners also offers a pretty solid dividend of $0.55 a share, good for a yield of 16.6% at current share prices. If the company’s hedging strategy protects the balance sheet enough to maintain that dividend through the current low price environment, it could make Memorial one of the more appealing small-cap oil stocks out there for the short and long term.
Buying Oil in this Climate is a Slippery Proposition
On the whole, it’s hard to view an end to sanctions for Iran as a good thing for an oil company. More supply is going to hurt producers, end of story. However, for those companies that are well-hedged against low prices, they can likely continue selling at the same price regardless of the market. The advantage they’re currently enjoying over their competition is only going to expand.
That’s only going to last as long as the hedges do, and many of these companies may not have a lot of protection that extends into next year or beyond. However, if you’re confident that oil prices will rebound in the long run, the current depressed state of share prices for oil companies could be viewed as a real buying opportunity. In which case, those companies who improved their financial situation relative to the competition through hedging could be the ones best suited to take advantage of rising prices if the Saudis ultimately opt to reduce production.
All told, anyone looking for a way to play the situation in Iran using small-cap oil companies should likely be looking long and hard at which companies are well-hedged into 2016 and even 2017. Hedge portfolios are currently extremely valuable and could help a company weather the current storm.
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